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Foolish Forecast: Blockbuster's Last Stand

Views you can use to get clues on the news.

Movie-rental chain Blockbuster (NYSE:BBI) reports second-quarter results Thursday morning. This Fool hung out with the ghosts of SEC filings past to give you the lowdown on the ailing giant, mired in a bloodcurdling rivalry with online-rental expert Netflix (NASDAQ:NFLX).

What analysts say:

• Buy, sell, or waffle? Nine analysts care to keep track of Blockbuster these days, slapping two buy ratings, six holds, and one sell on the stock. In our Motley Fool CAPS community, 966 users have chimed in with their ratings, making this a firmly established one-star stock.

• Revenues. The average analyst expects $1.25 billion this time, down from $1.31 billion a year ago in a seasonally weak quarter.

• Earnings. Wall Street can stomach about $0.30 of losses per share, which would be worse than last year's $0.13 loss per share.

What management says: Management held a presentation for its debt holders in late June, when CFO Larry Zine showed the explosive growth of its Total Access program and its willingness to pay down debt by liquidating assets. The single most telling line in the slideshow -- for reasons that will be apparent in a minute -- was this timeline item:

What management does: Blockbuster spent a few quarters climbing back to GAAP profitability by closing underperforming stores and otherwise tightening belts wherever they were found flabby. And then the aggressive push for Total Access domination happened. You can see that effect in the latest quarter, when margins dropped across the board.

The rolling-12-month numbers disguise the magnitude of the decline a bit. The latest quarterly gross margin was 51.1%, the operating take was a negative 2.5%, and the net figure a negative 3.2%. That's still a better take-home profit margin than the company is used to from 2006 and earlier, but not good news nonetheless.

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says: Only last week, JPMorgan Chase (NYSE:JPM) agreed to amend Blockbuster's credit facility, lowering the credit limit and adding new potential penalties. In exchange for the tighter credit terms, the bank waived the requirement to meet certain EBITDA targets for the 12-month period ending in July, though the requirement to meet revolving EBITDA goals still stands for future reporting periods.

But Chase made it easier to meet those targets by removing items like the $6 million litigation settlement in the patent infringement lawsuit brought by Netflix last year, and settled earlier this month. In fact, I'd venture a guess that this provision in the credit rules helped motivate Blockbuster to settle the suit, although I can't say whether Netflix knew about it in advance.

These credit changes mean two things to me. For one, the creditors want to be repaid at some point, and forcing a default today wouldn't put enough cash back into lender pockets to happify anyone. For another, the tighter spending limit and more punishing fee structure should motivate Blockbuster to actually deliver better EBITDA figures sooner rather than later, or else be prepared to worsen its credit situation even further by trading more waived default rules for even worse terms.

So I'd be surprised to see the Total Access blitz continue for much longer. In order to keep about half of its available credit in good standing, the company needs to show a total of $140 million or more in EBITDA for the second and third quarters combined. It generated $123 million in EBITDA in those quarters last year, so the company has some work to do.

Stay tuned. Blockbuster has no way to pay off this credit line today, so it may be time to abandon the no-holds-barred strategy very soon. After all, management already told its creditors as much.

Fool contributor Anders Bylund is a Netflix shareholder but holds no other position in any of the companies discussed here. You can check out Anders' holdings if you like. There are no late fees for Foolish disclosure.